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10 October 2017

Don’t Personally Fund Your Business Without Reading This First

Don’t Personally Fund Your Business Without Reading This First

A renowned biochemist just found out that tax codes can be more complicated than biotechnology. His mistake? Infusing his startup with millions in personal cash without paperwork to classify what the advance was: personal equity or a business loan. 

As this Forbes article points out, William Rutter is a highly respected biochemist who founded iMetrikus, a technology system that enables remote monitoring of patients' health. Rutter believed so deeply in his company that he infused it, first, with a $32 million loan that was converted into preferred stock (personal equity). He went on to loan the company over $120 million over the next few years—only this time with no written note, collateral, or interest payments. Therefore, there was no indication whether it was personal equity or a business loan.

When a potential partnership with Google failed in 2009, the company’s value tanked. It was then Rutter tried to at least get a tax advantage out of the bleak situation by claiming $8.5 million of the $43 million he'd recently advanced to iMetrikus was a business bad debt.  By claiming a business bad debt, Rutter was hoping to take an ordinary tax deduction on the entire loss.

The IRS didn’t buy it.

Instead, the IRS claimed it was personal equity-turned-bad-debt, which is a short-term capital loss only (limited to offset any gains plus $3,000).  Like so many otherwise-savvy entrepreneurs before him, Rutter fell victim to a lack of planning and paperwork when it came to funding his own business. Had he consulted a tax professional, he could have structured the entity and/or the transaction differently and obtained ordinary deductions for the entire amounts injected into the venture.

Forbes goes on to outline 11 factors that the IRS may consider when deciding whether an infusion of money into a business is personal equity or a business loan. Contact us to learn more.

Image Copyright: dolgachov / 123RF Stock Photo

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